January 5, 2024 – Both the stock and bond markets defied expectations in 2023. At the beginning of 2023, the consensus was that a recession was imminent. Stocks and bonds markets were thought to be bound for negative returns for the year. Fortunately, perseverance was rewarded for those who sustained a long-term investment strategy. The most predicted recession has not materialized, and we finished 2023, with the S&P 500 gaining over 26% for the year and bonds returning a respectable 5.5%.
These market gains are attributable to an overall healthy economy enabling a rebound from 2022. Inflation has moderated to a more sustainable rate from a high of 9.1% in June of 2022 down to 3.1% most recently in November. This slowing of growth to cool inflation has been accomplished without the economy tipping into recession. To the contrary, the U.S. economy has grown at a moderate 2.9% annual rate as of the third quarter of 2023.
Even more remarkable, we reached these lower inflation rates without net job losses as the economy has continued to create more new jobs. The current unemployment rate is a relatively low 3.7%, also unusual for a period of rising interest rates and slowing growth.
As a result of this stable economic environment, the Federal Reserve has ended its rate rising campaign and is expected to reverse course and lower short-term rates to a more neutral level in the coming months. Market interest rates have begun to decline in anticipation of these improvements in inflation and Fed policy. Economic growth and low unemployment have provided a further lift to stock and bond prices.
| Market Total Returns (including dividends) |
Oct. – Dec. |
2023 |
|
| Large Co. U.S. Stocks | S&P 500 |
+11.69% |
+26.29% |
| Small Co. U.S. Stocks | Russell 2000 |
+14.03% |
+16.93% |
| Foreign Stocks | DJ Global (ex. U.S.) |
+9.67% |
+15.75% |
| U.S. Taxable Bonds | Bloomberg U.S. Agg. Bond |
+6.82% |
+5.53% |
| Tax-Free Bonds | Bloomberg Municipal 3 Yr. |
+3.61% |
+3.46% |
| Commodities | Bloomberg Commodity Index |
-4.63% |
-7.91% |
As 2024 begins with very favorable conditions, there are always risks to manage, even with the most positive outlook. Neither inflation nor recession can be ruled out. But, at this point, the set up could not be much better for markets: declining inflation and interest rates, slower but still positive economic growth, low unemployment, and expectations of much improved corporate profits.
U.S. Stocks
After a very strong performance for U.S. stocks in general, plenty of opportunities remain. Lower interest rates stimulate consumer spending and help corporate profits. Also boding well for profits is the cost cutting companies undertook in 2023 in preparation for a possible recession. This leaner, lower-cost structure will likely result in better profit margins in the quarters to come. We see dividend-paying stocks benefiting from lower interest rate competition. In addition, sectors of the market that under performed during the rate-rising cycle—financials, energy, healthcare, and segments of the real estate market—are possible beneficiaries.
Foreign Stocks
There is an argument to be made for foreign stocks as well. Valuations in mature foreign markets are typically lower than for U.S. companies. But currently, these valuations are even cheaper than normal. A buyer can pay less in price for each unit of profit than normal. In addition, central banks around the world, with the exception of Japan, will likely follow the lead of our Federal Reserve and cut rates in 2024. We see opportunity in Europe and Japan, and we expect emerging market countries outside of China to also benefit from global growth.
Fixed income
With the economy continuing to grow, though more slowly, we continue to favor bonds with higher credit quality over lower. We also take advantage of higher rates in intermediate and longer maturity bonds by extending the range of maturities in portfolios. We “ladder” portfolios of individual bonds with similar dollar amounts in each maturity from two years to seven years.
We use tax-exempt municipal bonds in taxable accounts. In retirement accounts and other tax-free or tax-deferred accounts, we invest in taxable fixed income securities including CDs, treasuries, government agency bonds, and corporate bonds. For a short-term objective, we may hold money market funds for daily liquidity with yields remaining above 5% though we expect those money market rates to decline with Fed rate reductions.
While we discuss many areas of the market, our focus is on your particular goal and a personalized strategy to reach that goal. Your questions are always welcome. Please call or stop by the office any time.